RIP Chicago School of Economics: 1976-2008

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Some time ago, I asked if “Milton Friedman was the next economist whose once lauded reputation may soon slide ?”

Turns out it happened much quicker than expected. A long Bloomberg piece, Friedman Would Be Roiled as Chicago Disciples Rue Repudiation, discusses the tarnishment of the Chicago school of thought.

Its long overdue. From the efficient-market theories, to the concept of man as rational profit maximizers, much of the edifice that is was the Chicago school of economics is based on a foundation that is false, disproven or otherwise questionable.

I first encountered the Chicago theory in law school. The Chicagoists somehow read into law a market efficiency component that was never there. I recoiled against it — not because of the libertarianism, which I embraced. Rather, it seemed a backdoor way to circumvent democracy, and force into the legal system rules that were never debated, voted on, or agreed to by a representative government. I found the extremist legal theories of Judges like Richard Posner and Frank Easterbrook intellectually repulsive. They were undemocratic, anti-representative government. When I told a professor that the law and economics movement was an attempt at a political coup, he laughed and said, try to stop it.

I disliked the neoclassical price theory. It was authoritarian, a worship of a form of mob rule outside of the usual legal channels. The view that regulation and other government intervention is always inefficient compared to a free market has now been made laughable.  Its always the extremists that seem to control a discipline or school of thought. If I have any dogma, its extremism in all forms is undesirable (I know, radical, huh)

If there is one silver lining in the entire collapse, its that this group of intellectual charlatans have been revealed as utterly wanting. Oh, there will be some pushback by the Chicagoans. (Watch the comments for the cute little protests from law students who never practiced a day in their lives, and the biz school kiddies who never executed a single trade).

Anyway, here’s an excerpt from today’s Bloomberg:

“When Friedman’s Platonic ideas of free-market virtues are put into practice, they have too often generated a systemic orgy of competitive greed — whose remedies, ironically, entail countermeasures of nationalization,” Marshall Sahlins, an emeritus professor of anthropology, said during the debate, speaking in a room adorned with murals of female students parading through the campus in medieval gowns. Sahlins, 77, noted a few weeks later socialist and capitalist countries alike are regulating or nationalizing financial institutions in a rebuff to Friedman.

Off campus, the global meltdown is stirring anti-Chicago economists, who were voices in the wilderness during decades of lax government oversight of markets. Joseph Stiglitz, who won one of Columbia’s economics Nobels, says the approach of Friedman and his followers helped cause today’s turmoil.

‘Bears the Blame’ “The Chicago School bears the blame for providing a seeming intellectual foundation for the idea that markets are self- adjusting and the best role for government is to do nothing,” says Stiglitz, 65, who received his Nobel in 2001.

University of Texas economist James Galbraith says Friedman’s ideology has run its course. He says hands-off policies were convenient for American capitalists after World War II as they vied with government-favored labor unions at home and Soviet expansion overseas.

“The inability of Friedman’s successors to say anything useful about what’s happening in financial markets today means their influence is finished,” he says.

Instead, Galbraith, 56, says policy-makers are rediscovering the ideas of his father, Harvard professor John Kenneth Galbraith, and economist John Maynard Keynes of the University of Cambridge. Keynes, who died in 1946, argued that governments should spend to combat the unemployment that free markets tolerate. Galbraith, who died in 2006, rejected mathematical models and technical analyses as divorced from reality.”

That’s the phrase that best sums up the Chicago School: “Divorced from Reality.”

Chicago School repudiation?  Good riddance!

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Source: Friedman Would Be Roiled as Chicago Disciples Rue Repudiation John Lippert Bloomberg, December 23, 2008 http://www.bloomberg.com/apps/news?pid=20601109&sid=a3GVhIHGyWRM&


Originally published at The Big Picture blog and reproduced here with the author’s permission.

9 Responses to "RIP Chicago School of Economics: 1976-2008"

  1. Guest   December 24, 2008 at 7:20 pm

    You left off your list of erring law professors names like Richard Epstein and many of the other long-time denizens of the U of C law school. Epstein has spent the past 25 years teaching a theory of torts that has never been accepted by the courts in any century – but which omits virtually every accepted principle of law in order to purvey his own “Friedman-style” view of what tort law ought to be. Epstein’s latest corkbrained theory is that if one can not pay out of pocket for medical care at the item it is needed, then they should just die. After all, that is the “correct” result according to their precious free-market theories. Kindergarten teachers die, Wall St thieves live. Research chemists die, Paris Hilton lives.They are way way past the ‘let them eat cake’ school of thought. They have less than a firm grasp onn history. The kind of resource distribution which so enamors them has, in the past, lead to revolutions.I attended a different law school but my husband and law partner is a U of C grad. He told me that he spent an entire year in Epstein’s torts class and never heard anything about the law of negligence until he clerked for a PI firm between his 1st and 2nd year. A visting Professor from Cambridge back then described the lot of the the Friedman/law adherents as “bloody crackers.”The politest thing to say about Posner is he is one cold SOB – and would have been much happier in the Germany of the 1930s were he could reduce human beings to no more worth than components on a factory line. Mr. Spock and Commander Data have a better grasp of human behavior than Posner.BTW, there has never, in all of recorded history, been any system or country that had completely free markets. The Romans regulated business and trade, the governments during medieval times regulated business and trade (think ‘guildhalls’), ditto the reformation and then Tudor and Stuart times, and continuing onto the present.Their whole ‘free market’ has never existed and is simmply a fantasy they created to justify unmitigated and uncontrolled greed. Even under their theories, if one accepts that unfettered markets are the most efficient means of allocating money, labor and goods, that is a statement that begs the question. The central question are what goals is this supposed efficency supposed to achieve and whether the results of the ‘markets’ is acceptable to the society. Putting all the money into the pockets of Wall St screwups instead of maintaining the roads and highways or creating and educated population is neither a moral nor socially desireable goal.Friedman’s ‘markets’ and his theories assume that the only desirable goals of a society are to make as much money as possible and to allow an elite group to acquire as much of the available resources as possible. That is extremely elitist and generally results in feudal-type society where a small group controls the money, resources and power while the peasants live in squalor, die young and work from birth to death.

    • FM   December 24, 2008 at 9:30 pm

      efficiency![SP}

    • jlk   December 31, 2008 at 1:06 am

      <>…this is the same as a starving man with no money going to to a grocery store or restaurant and not being able to buy food—so he just starve to death! Is medical care a right? Is food a right? Is owning a house a right? Is owning a car a right? Is having out of wedlock babies a right? Is marrying the person of your choice a right? Please give definite answers for my peace of mind.

      • Anonymous   January 1, 2009 at 10:30 am

        Its not that complicated. You have to decide what parts of life are personal and which are not. TO the extent that you share a bond with ALL citizens, such as natural diasters or events (among which I include health events beyond one’s control), defense, basic infrasturcture,etc., you share “rights” and benefits provided. On the other hand, if one provides for one’s self in such matters, then one should neither expect or grant “rights” for such things from or to others. This, of course, brings us to how democratic societies organize themselves. We all do not have the same set of genes, and are not one “family” – even though contentious issues exist in all families, I dare say!As to food, would you live where people are provided the basics to survive when necessary, or in a “let them eat cake” culture where those without means starve (and go gently to their graves?) We know what happens in such societies.

  2. artichoke   December 24, 2008 at 9:03 pm

    It’s a credible theory of economics. Microeconomics and neoclassical theory are the best available for many situations. If you’re in a negotiation, you should be thinking microeconomics and game theory.But to say that people should be fully subordinate to such rules, that sounds like what you describe as Law and Economics, and that is wrong. I learned theory in the Yale Economics Department, and I don’t think there was a single student or faculty member who mistook the little toy models we built and analyzed for full descriptions of what is important in life.It sounds like some of these scholars read the conclusions of a model without understanding the assumptions and how it was derived. I never imagined until now that people with tenure at a good school could be so shallow.Maybe I just lack experience of law schools.

  3. OrlandoB   December 24, 2008 at 9:57 pm

    National exchange warehouses does no justice to human exchange of products and services. The whole concept of wall street, fiat currency, and central bank will lead this country to the unsurprising situation ahead of us in 2009 and beyond. There is only one conclusion to where this is headed. The only invisible hand I see is the international power structure that convinces us we live in democracies. Gerald Celente says next Christmas we’ll be looking for food instead of buying iPods.

  4. Craig J. Bolton   December 25, 2008 at 7:32 pm

    Hi Barry,I am an attorney who HAS practiced for 20 years. [Just looked at your bio and don’t see any reference to you ever practicing law, teaching economics or doing anything other than engaging in the voodo art of investment counseling] I am also a former academic economist, trained by mostly Chicago School professors.Frankly, I can’t make out what you’re babbling about. You don’t like people like Friedman, Stigler, Coase, and Posner [half of whom were awarded Nobel Prizes in Economics]. Well and good, we all have personality conflicts and paranoid reactions from time to time.Yet you never get around, exactly, to telling us what the problem is with their perspectives. Yes, you mention that they are simultaneously anti-democratic and glorify the mob [outside of approved circles of authority and power], but your arguments seem most to resemble Samuel Johnson kicking a rock and intoning, “thus I refute Berkeley” [a notably ignorant comment from someone who just doesn’t “get” what he is trying to criticize.

    • Barry Ritholtz   December 27, 2008 at 5:29 am

      To answer your query: Yes, I did practice law, yes, I have taught economics (NYU’s continuing ed school), yes I have engaged in more than voodoo.My writing is a continuum, and on my blog (ritholtz.com) you will see the full run of ideas, theories and intellectual discourse. As you correctly pointed out, this post is incomplete — because I have written about certain ideas and concepts again and agian, and its tiresome for the reader to see them repeated constantly. You need to see the full blog run to capture a broader sense of the argument.Finally, as to voodoo — you are preaching to the choir. Have a read of this series: http://www.thestreet.com/files/tsc/landingpages/apprentice/

  5. Anonymous   December 31, 2008 at 9:14 am

    (Sorry For The Long Post : Need to get a broader idea across)Your fascination with democratic principles and their apparent merits, or that of the law for that matter, are even more ridiculous than the Chicago School’s fascination with markets. Perhaps, if you were paying attention, you would have seen the intellectual death of democracy over the past decade, which was the growing academic consensus prior to the financial crisis gaining the public’s attention. This movement continues to gain momentum. It is only overshadowed now by the debate over Monetarism.Reliance on democratic processes, on the law, simply puts power in the hands of those with political power. Reliance on markets simply puts power in the hands of those with money. And in a redistributive fiat money system, that puts in the hands of bankers. If we look at history, markets do better with power than do governments as long as fiat money is not involved.Corporations, States, are political entities. Markets and partnerships are financial entities. Law is a political entity. Brokerages, Banking and insurance are market entities. What we have to understand are the limits of each: So that people can respond to patterns, but that choices are made by the market.So, what you’re making is the “Corporeal Error” : processes cannot reason. Humans can. Human have limits to their computational ability. But nearly unlimited pattern recognition. The market computes that which is beyond human calculation, but it does not see patterns in itself. Governments, that is, humans, can see patterns and react to them, but they cannot calculate anything of that enormity. And that means that in all but the most slow moving and rare circumstances, they cannot regulate it either. They cannot have the knoweldge to do so. They cannot make those kind of calculations.Cheap fiat money is the problem. Pure and simple. If you use it, you have to regulate it. If you regulate it, it will become politicized. If it becomes politicized, you will have too much money in the system for economic calculation to occur.The political answer is not so much regulation of actions and punishment, but regulation of ownership and liability. If you demand that a person have knowledge of his assets, ( in other words, if a lender cannot escape liability, right down to the lending agent,) you will both preserve the ability to make economic calculation without creating obstructionist legislation, professionalize the institution, as well as provide incentives, punishments, and a method of insuring against malfeasance. There is no reason that lending is not given the same serious public weight as is the law, and why bankers are not afforded the same status and same liability as lawyers. But the problem is not incentive, it is knowledge. The law incorporates this idea, for different reasons, but the difference between law and banking is simply past reconciliation versus future prediction.Centralization of computing technology and banking has created a day-laborer network of bankers who have little if any knowledge of money and banking, liability and risk, and where all decisions are made by people with no knowledge of the properties they lend against. This process of centralization has exacerbated the fiat money problem. (Fiat money has a widespread impact on misallocating human efforts). Centralizing banking has deprived branch offices of talent that has knowledge of what they’re lending against, and taken away the only good finanical advisor that consumers have ever had.It breaks the law of “you can’t average everything and apply it to anything”. Or “we cant have one insurance company for everything because if you do you haven’t insured anything, because you can’t.”.Actuarial and analytical evaluation of risk is only of merit for niches. If everyone does the same calculation they have elimiated it’s predictive value. And that happend industry wide. (the mathematics and logic of this are something too deep for this forum.) It’s simply impossible to place quantitative projections on risk SETS that are that complex. Only individuals can manage that risk, and only individuals can have knowledge of their properties. (Technically speaking, or at least, logically speaking, you cannot have property you do not know the use of. If you do, it isn’t property any longer, because the purpose of property isnt anything to do with ‘rights’ it’s entirely to do with economic calculation in a division of knowledge and labor. (We have laws because we have property, we do not have property because we have laws.) If I dont know about it, I can’t calculate it’s changing use in real time.So, we do not have any means of using mathematics to incorporate that level of knowledge, any more than we can use mathematics to argue court cases. And for precisely the same reasons. Lawyers are agents of the state. Bankers, as we use them under fiat money, are agents of the state. Law and Lending are parallel institutions epistemelogically. Our error is thinking that they are not.The only thing I ever agreed with Galbraith on in my life was that we needed to create a bank under the Freddie’s to buy back home loans, and burden the government with the problem that they themselves created. I am no one. But I was an early proponent. Galbraith started talking about it later. But he was correct. This would have, if implemented, put a process of control into place that would have prevented such a rapid collapse, and protected the consumer, who has now woken up, and decided that he doesn’t want to be the engine of the economy any longer.So, government is the problem. And it always will be. The political economy operates by entirely different means than does the productive economy. And people in the government are necessarily, and somewhat preferentially, ignorant of it.So there are your answers:1) Look at banking as we look at law – an extension of the state, and maintain accountability. (We did it for CEO’s why not bankers) You must have a stake of no less than X%, and you are liable, and need insurance for your lending habits. Insurance is a better regulator than the law, and much faster in responding. I’d even go so far as to say you need to pass the equivalent of a ‘bar’ examination to be a lender. This will dramatically improve banker’s salaries, decentralize banking, create a new wave of banking investment, destabilizing the old bank power structure, and better serve consumers who now will have people lend to them based on personal relationships rather than statistical analyses. This will create a new banking economy, and one we desperately need if we are going to have fiat money. This makes the individuals in banking regulate the monetary flow based on personal liability, rather than having the government regulate it based upon punishing greed. In other words, it makes people regulate themselves because they have the knowledge and incentive to do so.2) Create an institution that buys back bad loans for this crisis. We have done similar things before. Give the consumer a way to protect himself. This will create certainty, and it will cause a redistribution by market channels rather than by government.If you combined these two initiatives with a drive for a new national power grid, and say, electric cars, and perhaps, infrastructure improvements, you could refocus the economy very quickly. Banking and Energy are high performance and high value institutions. Focus the population on opportunities rather than crises. That is the regulation we need. that is what leadership has meant in all of history: to move a body of people who cannot move in any direction on their own. The longer you take, the more the population’s ‘momentum of thought’ will constrict, and the harder it will be to move them.This is the proper place for political leadership. Not managing calculation. We know socialism doesn’t work. But socialism is the politicization of the process of economic calculation, which is logically impossible and demonstrably destructive. But social services are possible, and have been since the dawn of the polis. The problem is creating social services, and redistribution, while letting the market perform it’s calculation. It is when politicians decide that processes calculate, or that there is a substitution for personal knowledge of property, that they destroy what it is they seek to protect. (we can have all the social services and redistribution we want as long as we preserve economic calculation, and do not let politicians make monetary decisions. This is one problem libertarian theory has solve but we would need to simply implement.)Chicago simply became too technical about quantification, and too religious about the human market – micro’s error is a mirror of macro’s error. Micro doesn’t see the stickiness of certain forces. Macro doesn’t see the failures it programs into humans. There is a place for government, and that is in creating and protecting the institutions that make calculation possible. It is not to regulate and calculate. They cant. It is to regulate so that others can calculate.That’s what the market does. That’s all it ever has. Government should only protect institutions of calculation. When politics interferes in those institutions, it attempts to calculate, and it can’t do that. Politicians cannot fall into the error of the political economy and think that they can do better than the market at calculation. This is the political equivalent of greed: we call it corruption: allocating property, for compensation in political power – even if we think we’re doing a ‘good’. Those ‘good acts’ become a separate economy when they become commonplace. Nor can the market think that it can build and manage institutions without regulation. Or that they can violate those institutions of cooperation: what we call greed.The problem we have, is that we ask the government to regulate both themselves and the market participants. We need someone to regulate the government.Unfortunately we killed off most of our kings. The most vain and criminal error ever perpetuated by democracy.Cheers